India’s GDP growth has picked up — recovering from 7.3 percent contraction last year, it is expected to clock in more than 9 percent in FY22. This growth has been fuelled primarily by government spending, exports driven by overseas recovery, and a falling rupee. Even private investment has started picking up pace. But, consumption, which comprises nearly 55 percent of GDP, is lagging pre-pandemic levels by 3 percent. For the growth to sustain, we need consumption to catch up.
However, there are a few hurdles along the way. First, inflation has been playing spoilsport fuelled by crude, commodity prices, pandemic-driven supply and demand imbalances, and demand spike as economies open up. While CPI at 5.5 percent is within the RBI’s comfort zone, WPI of 13.56 percent is at a record high, and points to rising consumer prices in the future as firms continue passing on higher input costs. Rural and middle-class households tend to have higher price elasticity, and thus, inflation has eroded their consumption activity. This is evident from languishing tractor sales, which is considered a proxy for the rural economy.
Furthermore, Omicron-led local restrictions have threatened incomes and employment of low-income households. Consumption by such sections has succumbed, given their relatively higher income elasticity.
Meanwhile, equity markets are hovering around 17,000, up from the 14,000 levels seen right before the pandemic. At the same time, Indian unicorns are rising exponentially, and so is the number of billionaires. This points to a K-shaped recovery. To prevent this, that is to make economic recovery more broad-based, Budget 2022 is expected to provide sops to benefit rural and other low-income households. This is also expected to get the government some brownie points ahead of the upcoming assembly elections.
Burning Question Of Fuel Prices
Geopolitical tensions in OPEC+ countries have added fuel to the fire of crude prices. With falling global crude stockpiles, economies opening up, and supply chain issues still unresolved, experts expect crude to touch $100/bbl by the end of 2022. The timing is unfortunate for the government as higher fuel costs may push purse-pinched voters away from the incumbent government, despite recent tax-cuts. For now, OMCs have not passed on the recent hikes — domestic fuel prices have stayed around the same levels since December 2. However, if they were to shift gears and start passing on the hikes, it would heighten the sounds of expectations for further tax-cuts.
The upcoming Budget, if prudent on fiscal considerations, is not expected to deliver any tax-cuts on fuel. However, as fuel prices rise further, and OMC margins contract, the government may have to bite the bullet.
Long-term View Over Populist Measures
The Budget should be cautious in not overspending on populist measures such as direct transfers, subsidies, and other sops ahead of the elections. Instead, allocations towards storage infrastructure, and agricultural technology would be more productive in truly supporting the rural economy.
Furthermore, allocations should be increased towards spending with high multiplier effects, including infrastructure, logistics, and PLIs. Sectors under stress, such as autos and aviation, are also in need of some relief.
Healthcare spending as a percentage of GDP is low, and should also be propped up as shortcomings of India’s health infrastructure have been brought to light during the pandemic. Some announcements are also expected around the ease of doing business as the government tries to bring in foreign investments amidst ongoing conflicts around tariffs and disputes with overseas courts.
We can also expect allocations to clean energy initiatives, so as to continue making strides towards India’s Climate Change goals, which have recently seen private participation accelerating.
Fed Complicates It For India
Sustaining growth should remain the prime focus, especially in the light of monetary tightening announcements by the US Fed. The US Fed has expressed a likelihood of hiking rates from March, and simultaneously putting an end to its bond purchases. On cue, US longer dated yields have already started rising, and currently stand at 1.85 percent, up from the lows of 0.5 percent in August 2020.
This has led to shrinking spreads between US and Indian treasury yields — from 500 bps to 488 bps in a month. As a result, India has witnessed massive capital outflows. While India’s forex reserves are in a much better place than during the 2013 ‘taper tantrum’, it isn’t nearly enough to sidestep rupee depreciation — the Indian Rupee has depreciated from 73.8 to 75.1 in the last 15 days. This increases the debt burden of companies loaded on dollar-denominated debt, and also, impacts equity markets as ‘smart money’ continues its exodus — more than Rs 18,000 crore of FII outflow has led to a nearly 6 percent drop in Nifty during the last 15 days.
The RBI would need to follow suit by raising rates so as to arrest the shrinking spread, slow down (if not reverse) the capital outflows, and control inflation. But, to do this, as the RBI iterated in its latest policy review, we must have growth that is broad-based, and sustainable going forward, even as pent-up demand and low-base effects subside.
A Balancing Act
Of course, expectations are plenty. But, they would have to be reeled in considering our already stretched fiscal deficit. FY22 budget had targeted a deficit of 6.8 percent of GDP, assuming lofty disinvestment targets of Rs 1.75 trillion. The achievement against this target has been Rs 455 billion (including dividends), which is disappointing, to put it mildly.
Of course, if the mega IPO of LIC materialises before the end of the year, it would take the achieved figure to a more respectable level. To be sure, there would still be a shortfall, and that would make this the third consecutive year of failing to meet the target. Thankfully, tax collections have been robust during the year, and are expected to support the deficit to an extent.
For FY23, experts are tagging fiscal deficit at over 6 percent of GDP in line with the previous Budget’s target of reining it in to 4.5 percent of GDP by FY26. Hopefully, experience will guide the government towards more modest disinvestment targets this year.
Impact On Equity Markets
If we were to take lessons from history, we would see that markets tend to be volatile leading up to the Budget, and correct thereafter. However, this time around, the story is quite different — global factors including the Fed policy, crude, FII flows, and cues from global equity markets are the primary drivers, rather than local drivers, including the Budget.
Having said that, as long as the Budget demonstrates focus on growth over populist measures, long-term prospects of the Indian equity markets remain bright.
Ananya Roy is a fund manager. Twitter: @ananyaroycfa. Views are personal, and do not represent the stand of this publication.
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